Class 3: The Five Forces

MG106 Strategic Management

José Ignacio González Rojas
j.i.gonzalez-rojas@lse.ac.uk

London School of Economics and Political Science

June 26, 2025

Welcome Back!

Quick Recap from Yesterday

  • Netflix: Business model innovation beats first movers
  • WHO-WHAT-HOW: Framework for analyzing business models
  • Today: Industry structure and profitability

From business models to industry analysis

Today’s Puzzle

How do companies selling
colored sugar water 💧
earn 35% profit margins
for over 100 years? 🤔

Framework Reminder: Porter’s Five Forces

Your analytical toolkit for today

The Five Forces That Shape Strategy

“Industry structure drives profitability” - Michael Porter

Your Mission Today

Four Questions to Crack

1️⃣ What makes concentrate producers so profitable?

2️⃣ How do they manage the value chain?

3️⃣ Has competition destroyed profits?

4️⃣ Can the magic continue?

15 minutes with your group - Use the Five Forces!

Group Discussion Time ⏰

Apply Porter’s framework to the case

Question 1: The Profit Mystery 💰

What makes concentrate producers so profitable?

Let’s Hear Your Analysis

What did you discover? 🔍

Which of the Five Forces explain
the 35% margins?

The Profitability Gap Revealed

Concentrate Producer Bottler
Gross Margin 83% 📈 35% 📉
Pretax Profit 35% 💎 9% 😔
Capital Required $50M $75M+ per plant
Plants Needed 1 nationally 80-85 nationally

Same industry, vastly different economics - Why?

Force Analysis: Barriers to Entry 🚧

What keeps new players out?

Think about Virgin Cola, Jolt Cola, OK Soda…

The Entry Fortress

  • 🏰 Brand Castle: 100+ years × millions in ads = emotional moat
  • 🚚 Distribution Wall: $6 billion to replicate bottler network
  • 🏪 Shelf Space Gate: Every slot taken everywhere
  • 📺 Ad Scale Mountain: Pay 2.2x more per share point if small
  • 📜 Legal Moat: Exclusive franchise territories

Result: Zero successful entrants in 50+ years

Force Analysis: Supplier Power 📦

What leverage do suppliers have?

Hint: What exactly goes into concentrate?

The Secret Recipe Revealed

What’s NOT in concentrate

  • ❌ Sugar (bottler adds)
  • ❌ Water (bottler adds)
  • ❌ Bottles/cans (bottler buys)

What IS in concentrate

  • ✓ Caramel coloring
  • ✓ Phosphoric acid
  • ✓ Natural flavors
  • ✓ Caffeine
  • ✓ THE SECRET 🤫

Cost: $0.12 → Sells for: $0.71

Suppliers have ZERO power

Force Analysis: Buyer Power 💪

Who pushes back?

Two very different types of buyers…

The Buyer Landscape

Where is power concentrated? Where is it fragmented?

Channel Power Reality Check

Channel Buyer Power Bottler Profit/Case Why?
Fountain 🍔 HIGH ⚡ $0.09 McDonald’s can switch
Supermarket 🛒 MEDIUM $0.23 Some negotiation room
Vending 🎰 LOW ✓ $0.97 Captive consumers
Warehouse 📦 LOW ✓ $1.00+ Drop size matters

Economics change dramatically by channel

Force Analysis: Substitutes 🔄

The $1 question…

Water is FREE 💧

So why pay for Coke?

The Substitution Paradox

Drink Price U.S. Consumption
Tap Water 💧 $0.00 Available everywhere
Coffee ☕ $0.50 17 gallons/year
Milk 🥛 $0.25/glass 22 gallons/year
Coke 🥤 $1.00+ 53 gallons/year!

Americans choose the most expensive option most often

Why Don’t Substitutes Substitute?

  • 🎯 Different job to be done: Not just thirst
  • 😎 Identity: “Pepsi Generation” vs water drinker
  • 🏃 Convenience: Cold, carbonated, everywhere
  • 🧠 Habit: 8+ cans/day for heavy users
  • 🎉 Occasion: Celebration ≠ tap water

Coke redefined what they’re competing against

Force Analysis: Rivalry 🥊

The “Cola Wars”

100 years of battle…

Who won? Who lost?

The Scoreboard: 1950-2000

Both grew by taking from others!

Smart Competition: The Rules 📋

Compete ON ✅

  • 🎭 Celebrity ads
  • 📦 Package innovation
  • 🎨 Brand extensions
  • 🏪 Retail promotions
  • 🌍 International expansion

NEVER Compete ON ❌

  • 💰 Concentrate prices
  • ⚔️ Direct price wars
  • 🏭 Stealing bottlers
  • 😈 Attack ads
  • 📜 Breaking contracts

Porter: “Price competition transfers profits to customers”

Question 2: Value Chain Control 🔗

How do they manage without owning?

The Value Chain Puzzle

Follow the dollar 💵

Consumer pays $1.00

Who gets what?

Where Value Is Captured

Upstream captures most value despite touching no physical product

Evolution of Control Strategy 📈

1899-1980: TRUST ERA 🤝
Independent bottlers • Perpetual contracts • Local princes

1980s-1990s: INTEGRATION ERA 🏭
Buy bottlers • Direct control • Capital intensive

2000s: ORCHESTRATION ERA 🎼
Anchor bottlers • Equity stakes • Control without ownership

Why the changes?

The Franchise System Decoded 🗺️

Why exclusive territories?

  • 🎯 Forces market saturation: Can’t cherry-pick profitable areas
  • 🚫 Prevents bottler competition: No price wars between Coke bottlers
  • 💪 Creates local champions: Invested in their market
  • 🔒 Legal protection: Perpetual rights = stable system

Brilliant design: Aligns incentives perfectly

Question 3: Competition’s Impact 📊

Has rivalry destroyed profits?

The Pepsi Challenge Story 🏆

1975: A small bottler in Dallas…

Started blind taste tests

What happened next?

The Ripple Effects

1975: Dallas experiments begin 🧪

1977: Pepsi gains share in test markets 📈

1979: Pepsi passes Coke in supermarkets! 😱

1985: Coke panics, changes formula 🥤

1985: “New Coke” disaster → Classic returns 🎉

Result: Massive publicity for both brands 📺

Competition increased total demand

Question 4: Future Viability 🔮

Can 35% margins last forever?

Storm Clouds Gathering ⛈️

The Numbers Don’t Lie

Metric 1970-1995 2000 Trend
Volume Growth 3-7% annually 0.2% 📉
Per Capita Rising Flat at 53 gal 😐
Non-carbs Minor 18% growth 🚀
Health Concerns Low Rising ⚠️

First stagnation in 100 years

The Five Forces Are Shifting 🔄

  • 🔄 Substitutes strengthening: Water, energy drinks, tea
  • 💪 Buyer power growing: Walmart, Costco consolidation
  • 🚪 Entry barriers lowering?: In non-CSD categories
  • 🥊 Rivalry intensifying?: Fighting over flat pie
  • 📦 Suppliers unchanged: Still weak

Which force worries you most?

Strategic Options for the Future 🎯

Option 1: Fortress 🏰

Defend cola profits
Harvest cash
Accept slow decline

Risk: Irrelevance

Option 2: Portfolio 🧺

Total beverage company
Buy growth brands
Leverage distribution

Risk: Complexity

Option 3: Geography 🌏

China: 22 vs US: 874
India: 6 servings/year
Massive potential

Risk: Different game

What would Porter advise?

Synthesis: Industry Structure in Action 🎯

Five Forces Summary: CPs Win 🏆

Five Forces Summary: Bottlers Struggle 😰

Key Lessons 🎓

1. Structure = Profitability

The Five Forces explain everything

Not luck. Not genius. Structure.

2. Position Matters

Same industry, different forces

CPs 35% margins vs Bottlers 9% margins

3. Smart Rivals Expand the Pie

Competition can create value

If you follow the right rules

4. Forces Evolve

Today’s fortress, tomorrow’s prison?

Watch for shifting forces

Your Takeaways 📝

Three things to remember

  1. ?
  2. ?
  3. ?

Write them down - 2 minutes

Before Next Class 📚

Read: Airborne Express

Preview:

  • Different industry, different forces
  • Can focus beat scale?
  • What would Porter say?

Decide: Groups for the Project

“Industry structure is not fate” - Michael Porter

See you tomorrow! 👋